Articles

Three times when it’s ok to change your asset mix

In some ways your investment asset mix is kind of like the luggage you pack for your vacation.

For some people they are more ‘lounge at the beach’ kind of people and their luggage will have a bikini and sun dress, sandals and maybe something for rain. Other people will be hikers and want great climbing shoes, shorts, and water bottles. Some vacations will be great for kids and others purely for adults. Some places have wide ranges of weather so you want winter coats along with a sweater. Some people travel light and take a bit of a chance, while others pack everything just in case. The key is that each person has different goals and is headed to a different type of vacation, and must pack their bags based on that.

Your investment portfolio is no different. It will look different for some people than others – depending on the type of people they are, and the stage of life they find themselves in.

Your mix of stocks and bonds is the foundation of your future investment returns and level of portfolio volatility that you will face.

Of course, there are many other pieces of the puzzle – such as income levels, tax treatments, leverage and a wide range of risks within the word ‘stocks’ or ‘bonds’. However, let’s stick with the foundational asset mix for now, because this is the piece that gets questioned the most when times are not so good.

The most common question asked when markets pull back would be “is now the time in the market to change my asset mix?” I believe the answer is almost always no.

There are certainly times to rebalance because markets have caused some imbalance in your target portfolio. If you think about it, if stocks have had a great run and they now represent 68% of your portfolio instead of 60%, rebalancing is essentially a selling of something that has done well and buying of something that hasn’t done as well. But rebalancing is different than meaningfully changing your asset mix.

What I am talking about is someone who was 100% in stocks deciding that markets have dropped so now they will sell half their stocks and put it in cash or bonds. I am talking about the person who was 60% in bonds, but saw stocks doing well so decided to become 80% in stocks. These are the kinds of moves that usually come back to haunt someone because they are driven from market movements and not from a change in a person’s own situation. They are usually a problem because timing the move to get out and get back in is extremely difficult, and usually late. The other problem is that it leaves someone with a portfolio at various times that is not the right one for them as individuals. It is only right for what the market had been doing recently.

I believe that there are only three times when one should change their asset mix:

If they have been living an investment lie – by that I mean that their current asset mix doesn’t fit who they are today. Examples might be the investor who wants investment income, but whose portfolio has lots of growth stocks that don’t pay a dividend. Another might be the person who says they are uncomfortable with too much risk, and wouldn’t be able to sleep if their portfolio was down 10%, yet are sitting on mutual funds that are 80% invested in stocks. These are people who have the wrong asset mix for their needs (emotional and/or financial), and should make changes to get it right. These people packed the wrong luggage.

If they need to draw more money than they did before – This impacts the short term cash needs of a portfolio, and might necessitate a higher percentage in cash or short term bonds in order to prevent a sudden sale of stocks or long term bonds at a bad time in the market. This usually occurs when there is a change in employment (retirement, unemployment) or a sudden increase in expenses (often health or education changes). This would usually necessitate taking a step or two back in risk. If you had a portfolio with 80% in stocks, now maybe it might move to 50% or 60%. You may also want to increase the amount sitting in a high interest savings account or money market fund to help cover off your cash needs for a year without any market risks. Here, the 4 star vacation that you hoped for, has to be downgraded to a 2 star.

If their investment world just improved meaningfully – this situation can come about when someone sells their house and rents or downsizes meaningfully. It can happen with a sizable inheritance or taking a pension in a lump sum of cash as opposed to the traditional monthly payments in retirement. The reason this changes your asset mix is because you now may have more assets that may never get spent in your lifetime or which will be invested for a long term before they are needed. Quite often this growth in a portfolio allows you to increase the risk of your overall investments to try to achieve a larger estate. One way to think of this might be to look at your portolio and determine how much you need to invest safely to cover your needs for the rest of your life. If the number is $1 million, and you have $800,000 in assets, then you can’t afford to be too aggressive with your investments. If the number is $1 million, and you have $3 million in investments, then this can guide you to a 67% stock portfolio, which you can afford to ride the stocks up and down, with the educated goal that they will be worth more in say 25 years than if it was invested more conservatively.

Time for an upgrade in your wardrobe for the upcoming vacation.

In all three of these examples, you will notice that none mentioned a sudden 10% drop in the TSX. Asset mix changes made because of great or bad investment markets usually do not pay off in the long run. What tends to pay off is having done your homework on what your financial needs are, to truly understand your ability to handle downside risks in the portfolio, and then to build a portfolio that will allow you to weather the investment sunshine and storms that will inevitably come in the future.

Reproduced from the National Post newspaper article 25th October 2014.